Principles of Set For Life: Achieving Financial Independence

Achieving Financial Independence Using Real Estate

You’ve graduated from medical school and survived your residency. Sure, you have a huge student debt load, but you also have been catapulted into a whole new and exciting income bracket. You may lean toward rewarding yourself for all your hard work, but before you take another step consider your future–your financial future. A common target for a new attending physician is achieving financial independence.

That means you need to build your wealth. Building your wealth will reduce your stress level and it will give you a greater sense of well-being. It also allows you greater freedom when making choices. Your next challenge is beginning the journey toward achieving financial independence, while you also build a foundation of financial knowledge.

What does that look like?

How do you start that journey?

How can a medical professional who is just starting out their career aggressively work on achieving financial independence? Scott Trench, President of BiggerPockets and author of Set for Life: Dominate Life, Money, and the American Dream gave me some insight.

What Does Your Path to Achieving Financial Independence Look Like?

Scott has written a book that discusses helping the median American ($50K-$70K) get to the first $200K in investable equity. During residency, a resident is making a similar amount to the median American ($50-$60K). The resident is making the median amount for approximately three to six years during residency and fellowship. Then things change with a huge difference between the median American income and the income of a new attending physician–as well as their debt level.

When considering a new attendings debt after completing residency:

15-20K consumer debt

280K student debt

Is there any frivolity involved in the accumulated debt? Possibly, a minute amount, however, family dynamics play a major role:

Is the resident married?

Are there children?

Is a partner staying home with the children?

I consider most of the debt very close to unavoidable, unless a single resident has the same amount of consumer debt, as the resident who has a family. Then you need to take into consideration that during residency the student loan payments are too large and the interest compounds. You need a plan to eliminate debt. And, you decide whether to pay off debt or invest.

In my situation, we could have made the increased payments, but we decided to invest in real estate. We bought a primary, then sold it, and then bought rentals. I decided not to pay the student debt. While it was compounding, I was sheltering in different places. People don’t typically do it this way. It may be because they don’t know to do it or they can’t do it.

Scott remarked to me that achieving financial independence starts as a remarkably simple equation given the fact that most new attending physicians are not going to be starting a side business, nor do they have money to invest at this time. Your path to achieving financial independence will start with the four pillars.

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The Four Pillars to Achieving Financial Independence

The goal of the four pillars to achieving financial independence is to generate a passive income in excess of your lifestyle needs.

Spending as Little as Practical

Generating a Large Earned Income

Investing Your Accumulated Assets for Greater and Greater Returns

Entrepreneurship

A median income earner will need to invest 50-100K in order to produce a return relative to their financial position. A physician will need to invest 250K. The question becomes how do you get to the first 100K?

Achieving Financial Independence: Getting to the first 100K in investable equity

If you are living off of 100K, which after taxes might be 80K, we assume a 50% savings rate to play with (invest). You are basically given a 100% raise after completing residency.

Do you store this in a bank account and begin buying income producing assets? Or is it better to pay down your debt? Pay off debt or invest, which one would you choose?

You must also take into consideration your debt repayment which might be $2,000-$2,500K.

There are two ways you can invest:

Paying down your debt

Purchasing income producing assets and paying the minimum on your debt

There are some questions to help you decide which path to take:

What is the interest rate on the debt?

Are you able to get a better rate somewhere else?

The interest rate is a wild card question. A lot depends on the interest rate and where it falls on a scale.

My wife’s interest rate was 6.75%. This is right in the middle of a gray area. Which leads to the questions:

How much work are you willing to put in?

How much risk are you willing to take?

Taking a risk is a better proposition if you know your income will increase in a few years versus remaining static.

The question is always: Which way will lead you toward your goal of achieving financial Independence?

What is an Income Producing Property?

An income producing property is an asset in the real estate space. This is an asset that you intend to use to produce income or you intend to sell. The money you gain is then used to invest or support your lifestyle. It is a stepping stone for achieving financial independence.

This real estate is not your personal house and not part of your net worth. It isn’t a luxury or a second home. And it is only an asset if you pay down the mortgage and no longer has that expense at all.

Scott told me if he was going to invest in real estate he would:

Get some education

Choose a solid, single-establishment

Stable property in a good area

Choosing a solid, single habitation means not buying something that needs a lot of time and attention in the form of rehabilitation. A stable property in a good area means you have a good class of tennant and the likelihood of problems is lower.

Scott started buying stable properties in areas that are in a transitioning area. Over time these areas will see dramatic price increases. He said he buys the worst property on the block and takes the time to fix it up. When he is buying property he makes sure he will not lose money today; he will spend time fixing the property up in order to add value.

He admits that today, he now will look at properties that are already in a stable area (versus a transitioning area). It will be either a single family home or duplex. It will be a place that attracts a quality tennant.

He stated that you make more money when you clean up a mess, but you make less on a stable property.

Scott’s Question: Am I going to get enough of a spread between the return from that property and the 6.75% interest rate that I’ve got on my student loan debt?

Scott suggested that the answer to his question would be “No”! He was careful to explain his thinking:

A physician has 50K to use toward achieving financial independence. His choice is to pay down his debt or buy a 250K duplex an hour away that produces $2,000 in rent or $500 in actual cash flow ($2,000 minus expenses). The next year he will make 6,000K in cash flow. He stated that this is not meaningful enough when compared to his financial position.

Scott was taking into consideration how much work, the emotional toll, and in order to make this a meaningful investment he would need to buy ten more similar properties–all while treating patients.

He said his preference would be to pay down the debt first. After three to five years of paying the debt down a physician would have a neutral net worth. He could invest and his potential for achieving financial independence comes with less risk at this time.

What does that look like?

Achieving Financial Independence with a Large Portfolio

You’ve paid your debts off. You are starting line on the race to build wealth. On your mark, get set…start achieving financial independence!

You start with 100K and no debt (no monthly payment of $2,500!). You can choose between investing in a single family residence or duplex.

Now you have choices. Now you can build your portfolio and your wealth! Scott pointed out that building a large portfolio is relative to your spending. This might mean a portfolio from $750,000 to 1.5 Million. Building a portfolio takes time. How can you build a large portfolio given your busy schedule?

Scott invests in passive index funds and after-tax brokerage funds. He invests the other part in real estate. His plan for investing in real estate is to make one significant investment every 12-18 months. He explained that “significant” to him has changed over the years.

Achieving Financial Independence and Creating a Blueprint

I want to be clear that creating a cycle for investing, or a blueprint is about making an investment plan. How do you want your investment plan to look?

This is not about your 401K or IRA money. I am assuming that these have already been handled. I am talking about after-tax funds. We are encouraging you to build a balance between a taxable account with index investments and income-producing real estate.

Scott said the meaningful lever in the financial model is the fact that you are earning so much money and have the capacity to live a great life–while still saving $50-75K a year. The key is your savings rate. It doesn’t involve your investment return rate until you pass $500,000 to a million in your portfolio. Your investments won’t be the driver for your portfolio for a long time. The driver will be the difference between your income and expense until you reach a certain point.

Real estate is a great way for a physician to build wealth. You won’t see the results in your portfolio for years. After years your portfolio will begin to give you a meaningful return in terms of cash flow and equity in relation to what you earn. You need a long-term mindset when working toward achieving financial independence!

Achieving Financial Independence in a High-Cost of Living Area

Everyone buying property in California is doing so based on appreciation. I asked Scott about the risk of buying based on appreciation in a hot market.

Scott’s Question: How do you generate enough cash flow where you are confident enough to remove yourself from your profession?

The answer is about achieving financial independence, early financial freedom and wealth. After achieving financial independence you have an abundance of choices regarding your lifestyle.

Achieving financial independence is about income versus wealth. As Scott states in his book, it is Mike Tyson versus Dr. Dre. In relation to our profession, physicians are notorious for having a high income, but low net worth.

Wealth is income that has been transformed into wealth, then those assets earn more income–which they turn into more wealth and lead to achieving financial independence. It is a function of understanding your spending. It’s savings rate that matters in the beginning, not investment return–that is for a later time.

Don’t Make Achieving Financial Independence Hard

Going through medical school, surviving residency and fellowship are the hardest parts of becoming a doctor. Don’t make achieving financial independence the hard part! Scott extends the advice to save your pennies and enjoy your life. He said you can have a good time if you are willing to live in a 1,800 square foot apartment close to work, instead of a 6,000 square foot house.

Curbside Consult

I asked Scott: Should a physician house hack? He described his own experience of living on $30,000 while earning $50,000, in order to save money to house hack. He saved $20,000 for the purpose of house hacking.

Scott put down $12,000 on a $240,000 property. He started biking to work. That enabled him to save $45,000 the next year. However, he states that for a physician the financial benefits may not be worth the lifestyle reduction costs.

He states that it is better to buy a house hack than a regular house. He said if you can buy a house that you would love to live in and rent out a couple of rooms to offset the cost–that would be great.

Doing a house hack is a great way for someone earning $50,000 to get ahead and accelerate their savings rate. For a physician, there is not a yes or no answer. It may or may not become a part of your plan for achieving financial independence.

Journal Club – Financial Residency

I wanted to highlight this article as it is really informative for some of the changes happening in 2019 that you need to be aware of.

First, the IRS has adjusted the maximum contribution to your 401(k), 403(b), most 457, and TSP plans from $18,500 to $19,000 annually for 2019. And, in case you were curious as to why, the amounts are adjusted as necessary to keep up with rising inflation.

At this point, you might also be wondering about your IRAs. Did we see an increase for those accounts as well?The other good news is yes! The past 5 years you have been allowed to contribute up to $5,500 annually for an IRA. For 2019, the new maximum contribution amount has also increased to $6,000. This applies to both the traditional IRAs and the Roth IRAs.

I also cover some of the differences between a 457 and your 401k or 403b. One difference is that a 457 plan is typically offered by local and state public employers, as well as some from the nonprofit sector. This type of employer-sponsored plan in a non-profit hospital. Another difference between the 457 plans and 401(k) plans is that you do not have the early withdrawal penalty if you take money out prior to age 59 ½. This could be a big advantage, depending on your financial circumstances.

Lastly, I go into some of the benefits or advantages of having an IRA (Traditional and Roth).

IRA is short for Individual Retirement Account. Think of an IRA account as a type of savings account but with tax advantages. All the income you earn from an IRA account (through mutual funds, stocks, and bonds) can grow without having taxes taken out. These accounts are subject to IRS guidelines and 2019 contribution limits, just like the other types of accounts.IRAs are divided up into two categories: Traditional and Roth. Each one is distinct, and like the other types of plans, offer various tax incentives that you need to understand. There are quite a few details when it comes to comparing the two types of IRA accounts, but here is a general overview.Traditional IRAs allow you to take advantage of tax deductions when you make the contribution. You would then pay taxes when you withdraw the funds for retirement (or whatever date you are targeting).Roth IRAs offer a tax advantage when you withdraw the money. The idea is that you will probably be at a lower tax bracket when you retire, then when you were contributing throughout the years. You will, however, pay taxes on the contributions up front.There are income and eligibility requirements so you will need to verify the details with a financial institution that offers the IRA. So make sure you check out the article posted here https://financialresidency.com/2019-contribution-limits-and-the-changes-impacting-your-retirement/